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We continue to favor EM and Asian local currency bonds, with the real rate differential relative to developed markets at a high level. We expect inflation to remain benign in most EM countries, and the fundamental undervaluation of the EM currencies supports this view. Within Asia, we expect Thailand to underperform. Thai LC sovereign yields are low relative to EM and likely to reprice gradually alongside US Treasuries.
Hard-currency (HC) sovereign bonds move Philippines to underperform
We also remain positive on EM HC bonds as they offer attractive sovereign credit spreads over and above what their sovereign fundamentals might warrant. Growth in EM appears to be bottoming out and economic stimulus in China will most likely keep this picture on track in the coming quarters. In Asia, we have moved the Philippines to underperform given high duration amid our neutral duration stance on US Treasuries. Moreover, carry relative to the EM benchmark is low. We also shifted China back to neutral as we expect higher yielding EM to outperform on fading idiosyncratic risks and a stable USD.
Asia FX: The USD stumbles
The confluence of more dovish expectations for US interest rates and the fall in the price of crude oil led to a downward shift in USD/Asia exchange rates over the last month. However, we would be cautious to project an extended move lower at this same pace given that market expectations on US interest rates might already have overshot and the oil price is more likely than not to continue to creep higher.
Asian FX against the USD Deficit currencies rebounded on lower oil prices
It should be noted, though, that the global growth situation and consequently Fed policy is still evolving and very likely to remain highly dynamic. As such, our expectations for USD/Asia exchange rates could well need to be re-evaluated fairly frequently over the next few months.
INR and IDR benefit from lower oil
For the USD/IDR and USD/INR, both the interest rate environment and the oil price contributed to our adjusting our 3M targets lower (to 14000 and 71.0 respectively), in addition to going neutral on the INR, from negative previously. Both Indonesia and India are due to hold general elections due April 2019 and April-May 2019 respectively but the risk of political uncertainty appears higher in India at the moment. Besides politiAAUC, it also appears likely that Bank Indonesia will prove to be somewhat less dovish than the Reserve Bank of India. The former is also likely to be less aggressive in buying USD, given Indonesias higher ratio of reserves to short-term external debt.
US-China trade agreement now more likely
Elsewhere, the US-China trade talks appear to have gone rather well and it seems that the market volatility in the USA has increased the pressure on both sides to come to an agreement. For sure, the process will continue to ebb and flow, but at the very least it appears to be headed in the right direction. The USD/CNY, meanwhile, had already moved lower on the earlier signs of rapprochement, and we do not envisage significant further downside given that current levels are in line with what is needed to negate the existing tariff regime, which is expected to be locked-in in the new agreement. The USD/CNY will also likely be supported by promises by China to shrink the bilateral trade imbalance, and expansionary fiscal and monetary policy. We see the pair at 6.85 and 7.00 in 3 and 12 months, respectively.
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